Investment impact of tax loss treatment : empirical insights from a panel of multinationals

TLDR: In this paper, the impact of tax loss treatment on multinational investment is analyzed based on data of German multinationals and the regression results suggest that a short carryforward time limit lowers investment in particular for firms with a high loss probability.

Abstract: We analyze the impact of tax loss treatment on multinational investment. Basically, two effects of tax loss treatment can be expected. First, firms make their investment decisions considering potential future losses. Then, the various types of conceivable loss offset provisions affect investment decisions. Secondly, existing loss carryforwards resulting from losses in the past affect the tax rate elasticity of current investment decisions. Our empirical analysis is based on data of German multinationals. We pay particular attention to industries having a high probability to make losses. Our regression results suggest that a short carryforward time limit lowers investment in particular for firms with a high loss probability. We only find mixed evidence that group loss offsetting provisions foster investment. Concerning the effects of existing losses carried forward, we find a reduced tax rate elasticity of investment for companies shielded by loss carryforwards.

Figures

Table 6: Existence of Minimum Taxation

Table 3 shows the regression results. Columns (1) to (4) refer to the panel fixed effects logit model, while columns (5) to (8) show the results for the count data model. All of the estimations relate to Hypothesis 4, predicting that the possibility to net profits and losses within the group should lead to a more distributed structure of investments.

Table 2, the long run effect is -0.325 / (1-0.402) = -0.543.

Table 7: Maximum Loss Carryback

Table 5: Maximum Loss Carryforward

Table 8: Method of Group Taxation

Full text

Dis cus si on Paper No. 10-097
Investment Impact of Tax Loss Treatment
– Empirical Insights
from a Panel of Multinationals
Daniel Dreßler and Michael Overesch

Dis cus si on Paper No. 10-097
Investment Impact of Tax Loss Treatment
– Empirical Insights
from a Panel of Multinationals
Daniel Dreßler and Michael Overesch
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neue ren For schungs arbei ten des ZEW. Die Bei trä ge lie gen in allei ni ger Ver ant wor tung
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Non-Technical Summary
While profits are taxed, no immediate tax refund is granted if a corporation suffers losses.
Losses can only be used to offset profits generated in other periods or by affiliated companies.
The tax loss offset rules, however, significantly differ across countries. While only some
countries grant a loss carryback option, a loss carryforward is always possible. Yet, in some
countries the intertemporal loss offset is subject to time restrictions. Moreover, several
countries have a group taxation which allows consolidation of profits and losses across
affiliated firms.
This paper analyzes in how far multinational firms factor the differently strict tax loss
treatment rules into their investment decisions. We consider two effects of tax loss treatment.
First, we analyze whether the various types of conceivable loss offset provisions affect
investment decisions when firms expect potential losses someday in the future. Secondly, we
consider subsidiaries which have already suffered losses and analyze if their investment
behavior changes once they have loss carryforwards.
For the empirical analysis, we use data of German multinationals taken from the
Microdatabase Direct Investment of the German Central Bank (Deutsche Bundesbank). Our
data allows a comparison of the investment behavior of multinational subsidiaries in 41 host
countries during the years 1996-2007.
Our results suggest that the existence of a group taxation rule in particular exerts a positive
influence on investments, which is even stronger for firms with a relatively high probability to
suffer losses. Regarding the investment structure, a group taxation regime makes
multinational groups distribute their investments across more subsidiaries. Concerning the
intertemporal loss offset, we find that investment levels are significantly affected by tax loss
offset rules if a subsidiary operates in an industry where the probability to suffer losses is
high. Interestingly, a broad time limit until unutilized losses forfeit, however, does not seem
to hinder investments.
In the second part of our analysis, we trace effects of existing tax loss carryforwards on
investment decisions. Our results suggest that the tax rate elasticity of investment actually is
significantly reduced if a subsidiary can offset taxable profits with losses carried forward from
previous periods.

Das Wichtigste in Kürze
Gewinne von Unternehmen werden im Jahr ihrer Realisierung besteuert. Verluste dagegen
können steuerlich nur im Rahmen von Verlustverrechnungsregeln genutzt werden. Diese
Regeln variieren von Land zu Land und über die Zeit. Nur einige wenige Länder gewähren
einen Verlustrücktrag, ein Verlustvortrag hingegen ist überall möglich. In manchen Ländern
ist der Verlustvortrag jedoch zeitlich beschränkt. Neben diesen intertemporalen Regeln zur
Verlustverrechnung, bieten manche Länder ein Gruppenbesteuerungssystem, welches die
Verrechnung von Gewinnen und Verlusten zwischen verbundenen Unternehmen ermöglicht.
Dieses Papier untersucht, inwieweit Unternehmen die unterschiedlich ausgestalteten
Verlustverrechnungsregeln bei ihrem Investitionsverhalten berücksichtigen. Dabei betrachten
wir zwei grundsätzliche Effekte der steuerlichen Verlustverrechnung. Erstens untersuchen
wir, wie die unterschiedlichen Typen der Verlustverrechnung das Investitionsverhalten von
Firmen beeinflussen, die potenziell mit zukünftigen Verlusten rechnen. Zweitens betrachten
wir Tochtergesellschaften, die bereits Verluste erlitten haben und analysieren, ob sie ihr
Investitionsverhalten angesichts der vorliegenden Verlustvorträge ändern.
Als Datengrundlage der empirischen Analyse dient die Direktinvestitionsdatenbank der
Deutschen Bundesbank. Sie erlaubt den Vergleich des Investitionsverhaltens von
multinationalen Tochterkapitalgesellschaften in 41 Ländern im Zeitraum 1996-2007.
Unsere empirischen Ergebnisse deuten darauf hin, dass insbesondere die Verfügbarkeit einer
Gruppenbesteuerung das Investitionsverhalten positiv beeinflusst. Bei Firmen mit einem
relativ hohen Verlustrisiko ist dieser Effekt besonders stark ausgeprägt. Hinsichtlich der
Investitionsstruktur führt ein Gruppenbesteuerungssystem dazu, dass Investitionen über mehr
Tochtergesellschaften gestreut werden. Im Hinblick auf die intertemporale
Verlustverrechnung zeigt sich, dass insbesondere solche Firmen deutlich auf die
Regelungsausgestaltung reagieren, die in Branchen mit hohem Verlustrisiko operieren. Eine
zeitliche Begrenzung des Verlustvortrags scheint keinen negativen Einfluss auf Investitionen
auszuüben, sofern der Vortragszeitraum hinreichend lang ist.
Im zweiten Teil unserer Analyse betrachten wir dann die Effekte existierender
Verlustvorträge auf das Investitionsverhalten. Unsere Ergebnisse zeigen, dass die
Steuersatzelastizität der Investitionen signifikant sinkt, wenn ein Unternehmen seine Gewinne
mit Verlustvorträgen aus vergangenen Jahren verrechnen kann.

Investment Impact of Tax Loss Treatment
- Empirical Insights from a Panel of Multinationals
*
Daniel Dreßler
**
Centre for European Economic Research (ZEW)
Michael Overesch
***
University of Mannheim
December 2010
Abstract: We analyze the impact of tax loss treatment on the size and structure of
multinational investments. Basically, two effects of tax loss treatment can be expected. First,
firms make their investment decisions in the face of potential future losses. Then, the various
types of conceivable loss offset provisions affect investment decisions. Secondly, existing loss
carryforwards resulting from losses in the past affect the tax rate-elasticity of current
investment decisions. The empirical analysis is based on data of German multinationals. The
data is taken from the MiDi database provided by the German Central Bank (Deutsche
Bundesbank). Regarding the tax loss treatment of potential future losses, our regression
results suggest that a short carryforward time limit lowers investments in industries having a
high probability to make losses. Moreover, we find significant positive effects of group loss
offsetting provisions on the size of investments and on the number of subsidiaries they are
structured across. Concerning the effects of existing losses carried forward, we find a reduced
tax rate elasticity of investments for companies shielded by existing losses.
Keywords: Corporate Taxation, Loss Treatment, Group Taxation, Multinational Firms,
Empirical Analysis
JEL Classification: F23, H25, H32
* We would like to thank the Deutsche Bundesbank for granting access to the MiDi database. We thank
Søren Bo Nielsen, Ulrich Schreiber, participants of the IIPF conference 2010 in Uppsala and
participants of the MiDi-Workshop 2010 in Frankfurt for helpful comments. Financial support by the
German Science Foundation (DFG) is gratefully acknowledged. The usual disclaimer applies.
**
Centre for European Economic Research (ZEW), L7,1, D-68161 Mannheim, Germany,
dressler@zew.de, +49 621 1235 377.
*** University of Mannheim, Business School, Schloss, D-68131 Mannheim, Germany, overesch@uni-
mannheim.de, +49 621 181 1715.

Frequently asked questions

Q1. What have the authors contributed in "Investment impact of tax loss treatment – empirical insights from a panel of multinationals" ?

The authors analyze the impact of tax loss treatment on the size and structure of multinational investments. The data is taken from the MiDi database provided by the German Central Bank ( Deutsche Bundesbank ). First, firms make their investment decisions in the face of potential future losses. Regarding the tax loss treatment of potential future losses, their regression results suggest that a short carryforward time limit lowers investments in industries having a high probability to make losses. Moreover, the authors find significant positive effects of group loss offsetting provisions on the size of investments and on the number of subsidiaries they are structured across. 

Q2. What are the future works in "Investment impact of tax loss treatment – empirical insights from a panel of multinationals" ?

The authors are, however, unable to identify statistically significant effects of the possibility to carry a loss back to previous periods. What is more, their results regarding the impact of the tax loss treatment on investment decisions of firms which will potentially make losses in the future suggest that a moderate restriction of the maximum time losses can be carried forward does not exert significant negative effects on investments. A severe restriction of the loss carryforward shows a highly significant negative effect on the investments of companies facing a considerable possibility to suffer losses. Furthermore, their results suggest that the structures of investments are significantly affected by the existence of a group taxation regime. 

Q3. What data are used for the empirical analysis?

For the empirical analysis, the authors use data of German multinationals taken from the Microdatabase Direct Investment of the German Central Bank (Deutsche Bundesbank). 

Q4. What is the effect of a group taxation rule on investments?

Their results suggest that the existence of a group taxation rule in particular exerts a positive influence on investments, which is even stronger for firms with a relatively high probability to suffer losses.